GFL Environmental Units

(Please note I wrote this a couple days ago when prices were different but didn’t get to hitting the ‘publish’ button until now)

GFL (TSX: GFL, also NYSE: GFL) is the fourth largest North American solid waste (garbage) collection companies, behind (Waste Management, WM; Republic Services, RSG; Waste Connections, WCN). GFL vomited out its IPO after a couple false starts in early March, just before the CoronaPanic really reared its ugliest days.

(GFL Prospectus from IPO)

If there is one guarantee on this planet, it is that waste collection will continue to be a viable business that can attract customers, and also be inflation-adjusted. There will be competitive cyclicalities that will cause margin compression, but the field also contains geographical barriers to entry that also will protect said margins, in addition to having captive customers (who the heck doesn’t produce waste?).

Financially, they have been operating as a roll-up operation; there is a lot of goodwill and intangibles on their balance sheet to reflect this history of acquisition (well beyond the equity line on the balance sheet). Patrick Dovigi is the founding CEO (from 2007) and retains a 3.7% economic stake and 27.7% voting stake in the company after the IPO – he’s also still very young – at the age of 40, he is still managing the empire.

At the beginning of March they went public at US$19/share, and the proceeds were primarily to reduce debt. They had a lot of it – about $7.7 billion, but this will be reduced to around $4.4 billion after the offering.

Financially, the operation makes money, especially when using the somewhat flawed EBITDA metric (approximately $800 million in 2019), but the “I” and “DA” amounts are significant – the company’s financial leverage was high, and garbage collection is intense on capital expenditures. They have been growing at such a large rate that they got overextended, and hence were forced to vomit this public offering out. They are going to enter a stage where they will become more efficient, and that should justify metrics that are closer to their counterparts (the companies listed in the first paragraph on this post).

(Prospectus for Tangible Equity Units)

They also sold “Tangible Equity Units” which trade as GFLU, which consist of 2.6316 shares of GFL plus US$8.5143 of a subordinated note. The units will be converted into shares on March 15, 2023 or earlier under some circumstances. The shares given will also be reduced to 2.193 if the shares of GFL trade above US$22.80, and it is a sliding scale between US$19 to US$22.80 (note that this represents US$50 of equity per unit). The subordinated note component has interest of 4%, and is amortized over a three year period with quarterly payments (consisting of roughly US$0.75/quarter per unit).

GFL currently trades at US$14/share and GFLU trades at US$41, or about a US$4.35/share above its immediate value and $17.51 if you assume full realization of US$50 of equity (which is currently worth US$36.84 at a US$14 equity price). Considering this as a hybrid instrument, you get a clean amount of upside for the first 36% of equity appreciation, and then this is effectively subject to a sold call option, until a further 20% appreciation from the US$19 par value.

An interesting hybrid instrument that I have taken a tiny stakes in, and no more.

Canadian oil

Did I mention that Western Canadian Select is trading at under US$10/barrel right now?

Only the most solvent are going to survive this, but pick the right survivors at the right time (likely nearing the end of this year or perhaps the beginning of 2021) and when US shale supply finally starts dropping to the point where light oil exports start to decline, it bodes fairly well for Canadian heavy oil to be imported into the USA, even with an oil-hostile administration such as the Liberals.

Heaven forbid, if Trans Mountain ever gets constructed (don’t hold your breath), there will be even more of a bounce. Keystone and Enbridge Line 3 will be providing a larger pipe to US heavy oil refineries, and if TransMountain is finished, then that will allow for another competitive outlet.

But for now, there is still too much US domestic supply, especially since demand is in the dumpster. The shale producers though will stop most capex, and there will be heavy declines.

Here’s another fun chart – US Gas Prices – Go to Sam’s Club (Walmart’s second-grade competitor to Costco) in Oklahoma and you’ll see them selling gas for US$0.99/gallon! I’ll save Canadians the currency and metric conversion – that’s CAD$0.37 per litre.

If I was on the retail side of things, if there was any mechanism where you can buy at retail your anticipated future level of gasoline expenditures for the next 20 years for 99 cents per US gallon, I’d be hedging at these prices. When that time is done, chances are electric vehicles will be much more prevalent.

May 2020 crude: US$23.07
December 2020: US$32.98
December 2021: US$37.07
December 2022: US$39.42
December 2023: US$41.10 ($1.40 bid-ask spread so midpoint price here).

Counting on the Federal government to do exactly the wrong thing

I bought some Bombardier preferred shares (TSX: BBD.PR.B/D) a few days ago.

If there is something you can be nearly sure of, it is that the Liberals have to subsidize corporations that are large net supporters of their power structure. This does include Bombardier, SNC, Power Corp, but in general if they exist in Quebec, they will enjoy a certain degree of protection.

CoronaPanic, Edition 13

As I write this:
S&P 500 -20.4% YTD
TSX Composite -21.7% YTD

Buckle up. After posting 3 monster-sized gains in a row, if you’re into the short-term trading thing it’s probably a good time to harvest a few bucks since the ‘second wave’ will start hitting the headlines. I’ve taken off my S&P 500 exposure, but will add it back on later.

This is where you are going to see supply chains get rationed and there will be further spin-off business disruptions that are second and third-order effects of shutting down half of a country’s economy and shutting in the population.

The numbers will get worse in terms of people confirmed with COVID-19, and the death count will rise. However, the growth of this will flat-line.

This is also the phase where you are going to see significant social unrest in the population. Shutting in a population for a week is one thing, but the second and third week you are going to get a lot of people that are going to be stir-crazy.

The primary thesis is the same, however – the trend between now and half a year later will be up, but there are going to be a lot of dips and drops as this panic continues to resolve itself.

Some other miscellaneous notes.

Tailored Brands (TLRD:US) I’ve mentioned before – they shut down their entire operation in the second half of March. Their stock is somewhat up, but their unsecured debt (July 2022) has cratered to about 25-30 cents on the dollar, and this is a pretty good sign that they’re going to go into Chapter 11. Considering the lease-heavy aspect of their business they are probably going to be using this as a way of breaking the leases, recapitalizing and getting on with it. They’ve got a billion and a half dollars of secured credit, so the unsecured holders are going to get killed (or more precisely, they’ve already been killed).

FTI Consulting (FCN:US) specializes in bankruptcy consulting, and looking at their chart, they’re right up there with toilet paper maker Cascades (TSX: CAS) as having a stock chart you’d never see any huge market dump on.

There is a lot of “liquidity sniping” on the TSX. I don’t know what this is formally called, but I’ll explain. You see a quote at bid 11.50 and ask 12.50, and you think it’s a really good deal at these prices (say you believe it is worth 17), and there is supply coming into the market (i.e. it is a down day in the market). You put in a bid at 11.55, and then some computer puts in a bid at 11.56, and you realize there’s no way you’re going to get any liquidity because the computers are going to beat you. The way you defeat this is to use hidden orders. You put a hidden order in at 11.55, and so when some guy puts in a market order to sell, you get priority at 11.55. The computer then sees the trade and has to adapt to dark liquidity, and it has a much more difficult time to do so – how much of the spread is actually being captured by you? Most brokerages don’t allow hidden orders, but Interactive Brokers does.

CoronaPanic, edition 12

A story of some collateral damage of the Coronavirus: A public example of a margin call – Royal Bank taking one of its clients to the cleaners.

The juicy details are here: 1257000-1257010-https-ecf-nysd-uscourts-gov-doc1-127126628149

3. Specifically, on March 23, 2020, Defendants issued margin calls to Plaintiffs on
the purported basis that the “Market Values” of Plaintiffs’ commercial mortgage-backed
securities (“CMBS”) that are financed through the parties’ Master Repurchase Agreements
(“MRAs”) have drastically declined in value as a result of the current market crisis. According
to Defendants, their calculations of these “Market Values” reveal a purported “Margin Deficit”
that permits them to require Plaintiffs to post large sums of additional cash or securities to meet
margin requirements. Defendants’ margin calls, however, are based on their entirely subjective
and self-serving calculation of “Market Value,” and do not come close to reflecting the
fundamental value of the securities or following the contractually-mandated means of assessing
those values. Indeed, because the “Market” is temporarily frozen, there currently is no objective
means of calculating “Market Value.” Moreover, the MRAs provide that “Market Value” shall
be based on a “price … obtained from a generally recognized source agreed to by the parties or
the most recent closing bid quotation from such a source.” MRA ¶ 2(j). It is entirely unclear
what “source” Defendants have been using to calculate “Market Value” in this illiquid market,
but it is crystal clear that Plaintiffs have not agreed to use it.

…

5. Yesterday (Sacha’s note: this was filed March 25, 2020), Plaintiffs learned that Defendants intend to conduct an auction that
includes nearly $11 million of Plaintiffs’ CMBS—at 11:00 a.m., EDT, this morning.

…

33. Notwithstanding the various government actions designed to return liquidity to
the markets and stave off mass foreclosures, on March 23, 2020, Defendants made multiple
margin calls on Plaintiffs in the total amount of $10,794,000.

Ouch. When playing with debt and leverage, playing with fire. Effectively, this mREIT got cleaned because they believed their definition of “Market Value” was what they believed they will get the assets for, while RBC’s definition appears to be “whatever you can auction the thing for”. Also I truly wonder what’s going to happen with all of this private equity and infrastructure investments going on that don’t have any active market – you can be sure that the level 3 value on balance sheets for the funds and such that own these assets are likely going to get downgraded pretty soon!

And for a final note, take a look at your Canada Pension Plan and ask yourself whether you can trust the stated value on 44% of the portfolio or so (I’m being generous and considering the “Other Real Assets” to be things like gold bars in a vault somewhere)…

When you have $400 billion in assets under management, you’re probably allowed to use your own definition of “Market Value” and not RBC’s.

Accounting-wise, I think the largest scandal-in-waiting is the proper valuation of private and infrastructure assets, or basically anything that doesn’t have an actively trading market. It would not shock me at all to discover there are plenty of assets out there being held on books of funds that are overstated by a significant magnitude.